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Homeownership is a big deal and can take a lot of work to achieve. Depending on your situation, you may need to save up a large down payment, prove your creditworthiness and then find a home a lender agrees is in your price range. If that sounds like a lot of work, you might be considering a rent-to-own home. Sure, it might sound like a shortcut to homeownership, but there are reasons why rent-to-own is bad news.
Considering a rent-to-own home? We’ve compiled the pros and cons of rent-to-own, so you can be well informed before you make your decision.
Rent-to-own contracts work as a middle ground between a lease and a loan. In a nutshell, a rent-to-own home is a property that you rent for a certain amount of time before you own that home. During negotiating, the landlord/seller and the renter/buyer will come to an agreement. They agree, in writing, on:
Once an agreement is reached, the renter/buyer pays rent monthly as they would if they were simply renting. Some portion of that rent is credited to the purchase of the home. At the end of the term, the renter/buyer has an option to purchase the home or renew the rent-to-own agreement.
Whether rent-to-own is a good choice for you or not depends on a lot of things, like your financial situation. Overall, though, rent-to-own is not typically an ideal path to homeownership for anyone who has access to mortgage options.
Perhaps the biggest benefit of rent-to-own is that it’s available to people who don’t have the credit history or financial situation to be approved for a mortgage. While a landlord might not be willing to take a chance on someone with a very poor credit score or other issues, they may be willing to gamble on someone who has mediocre credit but not enough cash for a down payment.
Another reason rent-to-own sounds attractive—to buyers and sellers alike—is that the agreement can be flexible. Buyers may decide the neighborhood or house isn’t for them after all, or have a change in finances that makes buying the home a bad idea after a year or two. With a rent-to-own agreement, you may have options for backing out of the purchase that are much easier than with a traditional home purchase.
For example, imagine you purchase a home via a mortgage but then get transferred to another state. You have to sell the home and buy or rent a new one. Depending on the market, you might have a hard time selling the home. And even if the market is in your favor, selling a home can take a lot of time and work.
With a rent-to-own situation, you don’t actually own the home. You might need to buy out of the terms of your rental agreement or come to another compromise with the landlord/seller. But at the end of the day, they still own the home, so it’s not your burden to carry with you into a new chapter of life.
For their part, sellers might benefit because they have an eager renter who’ll likely take better care of the home than a standard tenant. They also get steady revenue and don’t have to pay closing costs until purchase time.
The first and potentially biggest downside of rent-to-own is that it can be more expensive in the long term than buying a house via traditional methods. Whether this is a major detriment or not depends on the details, though, so you’ll have to compare how much rent-to-own might cost with how much interest you’d pay if you’re able to get a mortgage.
Many people mistakenly think their entire rental payment goes toward the purchase of their home. But that’s not usually the case. You may pay $1,500 in rent with only $500 of that considered rent credit, for example. Rent credit is the part of your payment that’s “saved” toward the purchase of the home.
So, consider that example: You pay $1,500 in rent for three years. That’s a total of $54,000 paid. But only $18,000 of that goes toward the purchase price of the home.
While it might be easier to get out of the home than if you bought it outright, if you do change your mind you typically don’t get that money back. Most rent-to-own agreements dictate that the landlord/seller gets to keep the money.
Some rent-to-own contracts also have clauses that cancel the entire deal if you miss or are late with even a single payment. This is another way you could lose your entire investment if you’re not careful.
The Federal Trade Commission also points out the potential for issues and scams, so it’s important to do your homework if you rent to own. Make sure the landlord/seller does actually own the property and that they’ve paid the required property taxes.
You may also want assurances that the owner will continue to pay the mortgage on the home, if applicable, and handle certain repairs and maintenance. Otherwise, you could end up working to buy a home that ends up getting foreclosed on or falling apart around you.
Another potential downside of a rent-to-own situation is that you’re not improving your credit by making timely mortgage payments. Most mortgage lenders report timely payments to the credit bureaus, which can be a positive impact to your credit. However, landlords don’t typically report timely rent payments.
You can ensure your timely rent payments are reported as a tradeline on your credit reports, though. That’s true whether you’re renting to own or just renting while you save up for a down payment. Build It from ExtraCredit feature lets you get current rent payments added to your credit report to positively impact your score.
Before you decide to rent-to-own, consider some other options. Here are some alternatives that might work for you.
Is rent-to-own a bad or good idea? As with any financial decision, it comes down to the details. But in many cases, rent-to-own is an expensive and potentially risky path to homeownership. So, always read the fine print and consider all your options.
December 13, 2023
Mortgages